1. If we don’t take “tough fiscal action” this time around, how much more will those special fiscal privileges (I’m not sure there is a single appropriate neutral term for the whole of them) become entrenched and difficult to dislodge, even when later macroeconomic conditions call for such?

2. What is the underlying rate of growth in the U.S. economy today, and how much higher (lower?) is that rate likely to rise (fall) over the next ten or so years? In other words, how much better (worse) an environment will we have for fiscal consolidation in the medium-term future? And at higher rates of growth, if we get them, how much harder is it to dislodge special fiscal privileges?

I submit that no one has very good or very certain answers to these questions, given the current states of public choice theory and the macroeconomics of growth. And if analysts do not have very good answers to these questions, dogmatic positions about the “fiscal cliff” are to be avoided.

If you read analyses which do not raise and consider these questions, fear that snake oil is being served up.

I don’t expect I’ll be doing any day-by-day tracking of this new Washington drama, but it would not hurt to remind yourself of this post every few days or so.

1. Standard economics used to be counter-cyclical policy. Take tough fiscal action during prosperity, loosen during times such as this.

Clinton took tough fiscal action by raising taxes and sharply cutting the deficit (with no support by Republicans). Bush saw this and cut taxes (with full support of the Republican congress). Consider that when suggesting “tough fiscal action,” especially in times such as this.

I’ve also demonstrated here previously that yes, Clinton raised taxes (how brave for a D to raise taxes), but the deficit cutting was mainly from windfall capital gains, a la the irrational exuberance. The bubble giveth, and the bubble taketh away. I’d be happy to view consider counter-claims.

There was nothing countercyclical about either decision. Clinton’s tax increases were designed to be permanent, and so were Bush’s tax cuts. Further, Bush’s tax cuts were proposed before the economy tanked in his first term, even if implementation was likely helped by economic conditions.

We humans do not do cycles, that was the most recent revelation in econometrics. There are no cycles in the economy, go look, do not exist, never did. Cycles are an invention of the econometrics system, humans themselves do not worry about time constraints, we worry about redundant transactions. The result is 30 years of bogus errors by our fine lot of math challenged economists. Otherwise, why do we have 18T in debt over the period in which cycle theory was supposed to have stabilized things?

In other words, the increased tax revenue from rate cuts, forced on Clinton by Republicans, was incentives to just pump and dump asset price inflation and high rates of asset churn which ultimately transferred wealth very inefficiently from stupid workers seeking to make money in the tax preferred ponzi scheme because work was being destroyed by the increased relative tax on labor income.

That means Republicans, Romney, Ryan ran and run on creating the conditions for pump and dump asset churn to create wealth for the wealthy 1% who understand the game while impoverishing the 99%.

And to think the majority of the people thought Romney was better at managing the economy. If I were a betting man, I would wager the same people consider Megabucks to be a sound investment too.

False. His tax increases did not have a major affect on the deficit. The budget battle in 1995 was precisely over $200 billion deficits off into the future, which Clinton did not seem to mind. The Republicans forced him to deal with the deficit and it came down sharply after 1995.

One of the interesting points of all this fiscal cliff talk is that you can see the small role of the Bush tax cuts in current deficits. Less than 20% of a $1 trillion deficit.

This is not an easy question to answer. If you look at the initial CBO/OMB projections and try to compare those to actuals, it is difficult to keep all else equal. But.. I recall that each year after 2003 when the full cuts were implemented, revenue was “unexpectedly” higher than anticipated. Despite the two wars, deficits fell each year, reaching $161 billion in FY 2007. After that, the financial crisis, followed by Obama I.

If that’s the case why do we even say bush tax cuts contribute 20% to the current deficit.
For all we know there is a possibility that in the absence of these tax cuts, tax revenues might’ve been even lower right?

Higher taxes on asset churn and pump and dump make the incentives to work higher. The Bush tax cuts were higher for for pump and dump, so that means the higher taxes on labor income destroyed the incentive to work. The result has been lower and lower rates of work, but higher rates of gambling to get rich, but the only people who get rich are those who gamble with the money they convince workers to “invest” with them.

Hey, refi your house so I get a fee and so my buddy gets a fee selling it to bankers who get a fee packaging it and selling it to your pension fund and then bets it will fail because I promise you that you can absolutely refi in two years before it jumps to 10% interest from the 2% teaser, and don’t worry, the refi will be instant because your house will be worth 150% of what its worth today, because house prices always go up in price – see look at prices from 1975 to 1985, and 1995 to 2005 -straight up and never down.

Besides, the Clinton tax rates were so high, even Mitt Romney had to get a job to pay his taxes – after the Bush tax cuts, Romney became part of the long term unemployed who hasn’t worked in 12 years.

The only reason Clinton “took action” was cause he lost big to Gingrich, including welfare reform. He was able to balance his budget as a result of skyrocketing stock prices, the tackling of the S&L problem (real estate bubble… hmmm that “thing” again today) by Bush I, and a wholesale cutting of the military (how’d that work out? — not good). additionally, for you to imply that raising taxes is the answer to the problems this time, you’ll have to explain how much revenue will be raised by said increase and compare that to the budget deficits. Let me give you a hint: raising said taxes will raise $50-80B per year, but not do much for the spending which has led to a deficit of >$1T per year. The Democrats are no longer the tax and spend party of the past. They are the spend and then tax party. actually, this is incorrect: they are the spend, vilify and then tax party. I hope the Repubs give them what they want, and then the deficit remains >$1T per year. [I’d love to see the Repubs agree to a tax increase – but implement with a 1 yr lag based on previous years spending reductions, but they lack the backbone and brains to do this.] What will you say then? Or will the goalposts shift again? Will you ignore the huge expanse in social program spending? And continue to vilify everyone who does not pay their “fair” share? who decides what’s fair? You? The govt? Who? Non-taxapyers?

All good on points one and two, but the term fiscal cliff makes a point. (Agree the terminology can get carried too far…I detest the fiscal clifflet term). Suppose the tax code is not nailed down in a timely fashion, many of the expiring tax provisions go out through withholding. January could be a rude awakening for working households who are doing their level best to ignore the policy shenanigans in DC. I’ve listened to household survey tapes and “fiscal cliff” is the not the term I could imagine them throwing around if the payroll tax cut and the Bush tax cuts expire even temporarily. I don’t understand why we are playing chicken with people’s lives. Stimulus is supposed to end and fiscal paths are supposed to be sustainable. There’s plenty to debate on timing and details but it would be a shame to debate past the decision.

PS “I don’t expect I’ll be doing any day-by-day tracking of this new Washington drama,…” I think it would be awesome if you live-blogged the fiscal cliff live DeLong does WWII. But then again I already have Jon Stewart to keep me in the loop on politics.

I wrote questions for nationally representative survey looking for your type, a self-identified Ricardian-equivalent household (or as you call it a rational expectationist)…those who save away their stimulus income because they think some day the bill with come due to them. Guess what (for better or worse) you are rare. I meet more of you in econ seminars than in household surveys. (One economist even proudly revealed that he updates his own life-cycle budget spreadsheet every year on his birthday.) All the work I’ve done on financial literacy tells me it would be great if people were more forward looking and understood basic financial principles, but the reality is most are just focused on living their lives. Effective policy, in my opinion, is built around the realistic behavioral responses (and preparations) of many, not idealized behavioral responses of few.

I get this. If everyone were a rational expectationist, there would be no fiscal cliff to discuss. But what do you think? Is my view, that everyone should explicitly ‘own’ their share of debt, a nutty thought, or is it grown up and rational?

I happen to think my view is the correct way to think about it, and anyone who doesn’t think this way is not as rich as they think they are. But I understand the appeal of the ‘debt doesn’t matter’ pitch, and, hey, it accords with how people live their lives. Government debt is remote- next month’s rent is tangible. So we pursue the path of least resistance, until we become Greece and it’s too late.

I’m more forgiving of simple politicians, like Dick Cheney, who pander to the ‘debt doesn’t matter’ crowd than Nobel Prize winning economists, who really should know better. They should be ashamed of spouting such twaddle in defense of some purely political goal (lower taxes, more spending).

Once upon a time, people understood this. In 1946, a nation much poorer than this one set about paying off it’s colossal federal debt in a matter of years. But anyone under the age of 50 has only known deficit spending. After 50 years, it must be benign right?

How did we come to such a pass when the easily understood idea of ‘expenses can’t exceed revenues’ is such a rare and exotic view? Tweren’t always that way. Perhaps I’m just a simpleton for thinking it can be that way again.

The Federal government faced its first fiscal cliff during Nixon’s second term when he refused to spend funds appropriated by Congress in order to deal with a rather small deficit and debt. Congress responded by enacting the Budget Impoundment and Control Act which facilitated spending in the short term while establishing a budget process, including CBO, which was supposed to provide a mechanism to reduce deficit and debt in the future. We have faced multiple fiscal cliffs druing the 40 years since the first one. The response has always been the same; increased spending or tax cuts to make life easier in the short term combined with some sort of commission, spending caps, legislative triggers, automatic sequestration or solumn promise of fiscal responsibility in the long term. The short term spending is always enacted, the tax cuts are sometimes enacted, the long term fiscal disipline is never enacted. it is the fiscal equivilant of treating cancer with morphene and laitrile. No reason to believe it will be any different this time.

Republicans have not “always” been president during the past four decades. Carter dealt with the problems with higher taxes and reduced spending, and Clinton increased taxes and cut spending. HW Bush increased taxes but was forced to deal with problems he inherited from Reagan’s policies with higher spending. All three got seriously punished for doing so.

Obama learned from their experience: working to reduce the deficit will get you punished by the conservatives who run on the free lunch of tax cuts curing all ills, and tax cuts generating more revenue so spending can go up.

If we go over the cliff we’ll have higher taxes for those who pay taxes and a cutback in spending that represents merely 1/10th the annual shortfall. That’s hardly a balanced approach. There likely will be a compromise before January with the Republicans caving on marginal rates for, perhaps, maintenance of the estate tax at 35%. Spending cuts will be entirely symbolic and we’ll continue with yearly trillion dollar deficits or more for the next four years. In 2014 and 2016 the Dems are going to seriously own it.

The country is run by an kleptocratic oligarchy that controls both parties and is happily running the country into the ground.

The main goal of this oligarchy is to raise taxes and increase control of the masses. We have been assured they will propose greater political centralization and crony/socialism/totalitarianism as the solution to any crisis(“opportunities”) they create.

Also, Obamacare’s new taxes kick in. And SS and Medicare’s revenue deficit continues to grow rapidly. But yes you are right, it’s an austerity budget. And better off now, that pushing this a further 10 years down the cliff.

Has anyone ran the numbers on what the US fiscal picture would be like, assuming deficits in the current range, no changes to entitlements and Interest rates on Treasuries rising to historical averages? Assuming those caveats, what percentage of the Federal budget would then be dedicated to interest payments? And what would be the likely reaction of the Japanese and Chinese towards a US government that starts seriously considering a default?

I can’t imagine the Chinese would be nearly as sanguine towards us as the Germans are towards the Greeks. Just something to ponder.

Your comment got me thinking. If we go over (through) the fiscal cliff and there isn’t a catastrophe, the road to a more stable budget balance is clear. Those predicting disaster will be discredited. Not sure that the Obama administration would like that – that means more taxpayers and a cut in spending (small though it may be).

Nonsense. Reagan raised taxes. Bush I raised taxes. The hysterical rhetoric around “slashed budgets” “deep cuts” “balancing the budget on the backs of [insert favorite special interest]” has no parallel on the tax side, even though none of these things have ever really happened.

What a fantastic alternate universe you live in! In the real world, we have Grover Norquist pestering Republican pols to sign pledges never to raise taxes (which I don’t think Reagan and Bush I never had to do), and Republican pols ACTUALLY TAKE THAT FOOL SERIOUSLY. The vast majority of House and Senate Republicans have signed his pledge. Now, that orthodoxy may be cracking, but even if enough House and Senate Republicans break it to pass some kind of “grand bargain,” I very much doubt that it will be a majority of Republicans. Who wants to face pissed off Tea Partiers and get kicked to the curb in the primaries? Come on, just because you guys are independent-minded libertarians doesn’t mean that Republican Party thinks just like you do.

Fine, raise taxes. You’ll find little or no revenue growth, though, as Bush’s tax cuts (and Reagan’s) actually increased government revenues. The problem has always been the unsustainable growth of entitlements, not other governmental spending nor insufficient tax rates. We need to make spending cuts of an order of magnitude greater than those we’ll get with the fiscal cliff and, of course, we’ll never get them.

MD: Guess everyone agrees that the Bush tax cuts for the “wealthy” constitutes a very small part of the deficit (20% is the figure often cited). Regarding Bush tax cuts for other income groups – Obama is not in favour of raising them regardless of what Grover Norquist thinks.

Then why blame the Tea party/Norquist/Cantor so much.
If anyone is serious about the “Cliff” and its long-term repurcussions, the place to focus on is Entitlement reform and not taxes.

“1. If we don’t take “tough fiscal action” this time around, how much more will those special fiscal privileges (I’m not sure there is a single appropriate neutral term for the whole of them) become entrenched and difficult to dislodge, even when later macroeconomic conditions call for such?”

I use:
100 million middle class households.
Roughly 2% borrowing rates.
Multipliers now known to have been less than one since 1980 and 18 T in debt

or
360 B in interest payments charged to middle class, or 3.4 k, about 5%? of middle class wealth lost because of deficits don’t matter. Every four year the government in DC wipes out about 2% of the middle class.

That is a lot of middle class income to lose, and without the middle class default is the only result.

The most important political position today is “I have nothing to do with this.” If they go off the cliff for even 1 day and need to pass everything fresh, the House GOP might oppose it; then it gets passed with moderate GOP votes. Then the conservatives will own the most important political real estate and when everything falls apart, they can say they had nothing to do with it and even voted against it.